CFOs’ role mitigating procurement risk in a challenging global trade environment
Business supply chains are under increasing threat from the current global geopolitical situation. Chief financial officers are ideally positioned to foster dialogue with procurement and the wider business to mitigate risk and protect long-term profitability.
Chief financial officers (CFOs) are acutely aware of the fast-changing geopolitical situation, but they may not have fully considered their own crucial role in mitigating resulting procurement risks.
There are multiple emerging challenges to business stability worldwide, from rapidly shifting policies being pursued by US President Donald Trump, including tariffs on Canada, China and the European Union, to the threatened response of those who fail to abide by US sanctions on Iran.
Also, there is the election of “nativist” politicians in several other countries, the massive uncertainty around Brexit and the potential currency fluctuations, and resulting demand and supply-side economic shocks, which may result.
The rules-based, predictable globalisation that businesses have broadly been able to rely on for decades is suddenly no longer certain.
Three quarters of firms are aware of the challenge and actively looking at broader risks to their supply chains, according to research by global procurement consultancy Efficio.
Some 78 per cent are considering how to identify and develop new, safer sources of supply, while nearly six in ten are investigating switching to local sources for critical goods and services.
As their operating environments change, CFOs must ensure the profitability of their business is protected. This includes understanding how the supply chain will be impacted by the changing geopolitical environment.
CFOs can be so focused on managing their budgets and achieving cost targets that they may not think they have time to look at procurement and supply chain risks. But they are often best positioned to broker discussion on this because of their clear view of, and access to, all departments. Once they begin to understand their supply chains, looking not only at suppliers but also at suppliers’ partners, and the trade-offs the changing business environment requires, good CFOs can facilitate a healthy discussion.
Tariffs, Brexit and beyond
There is no doubt that the current global geopolitical situation poses significant operational and financial risk to businesses, and rising tariffs between nations mean supply chains will see rapid shifts in cost and availability of essential commodities and goods.
With the US imposing tariffs on $250 billion of imports from China and China retaliating with penalties on $110 billion of goods (albeit suspended for 90 days), companies must consider the potential cost of moving goods around the world.
Efficio’s survey shows that four in ten firms have yet to model different scenarios. “For UK CFOs this means, as an example, considering how Europe could be a beneficiary of the current trade war between the US and China, but equally how it might potentially suffer if caught up in a more protracted dispute,” Mr Black says. “The question that CFOs need to answer is how best to protect the business from changes, while exploiting the opportunities they may present.”
Supply chain costs face other pressures. Commodity prices, including for oil, natural gas, coal, metals and agricultural products, have been steadily rising in 2018. Meanwhile, labour costs in East Asia, from where many raw materials and completed goods originate, have tripled in the last 20 years.
Phil Woode, senior manager at Efficio, says: “There are up-and-coming potential supplier nations beyond India and China, such as Thailand and Vietnam. Companies should consider how they might drive down costs by broadening their traditional sourcing approaches.”
Meanwhile, the UK and the rest of Europe face significant uncertainty over Brexit. The terms of a separation deal, if one is agreed, are far from complete. “It is particularly worrying for companies with supply chains that are heavily reliant on the European Union,” says Mr Woode. “There’s also the impact of a major drop-off in freedom of movement that will affect many sectors. The UK exit will have direct implications for low-margin industries, such as construction, care, agriculture, retail and distribution, resulting in further cost pressures.”
Currency devaluation could happen in the event of a “bad deal” or “no deal” Brexit scenario, and there are significant concerns that a devalued sterling against the euro and other currencies would wreak havoc on procurement costs. “Many companies are still playing a wait-and-see game, but they need to consider how various scenarios would impact costs, the bottom line, inventory levels and working capital, and cash flow,” says Mr Woode.
If businesses are to limit the risk presented by these global challenges, they must be prepared to foster comprehensive interdepartmental engagement.
“This discussion needs to involve understanding the risks, the new opportunities and how to adapt to these vast changes,” says Mr Black. “For the topic of currency devaluation, as an example, there would need to be detailed planning by procurement and sales and marketing teams, alongside the CFO.”
Removing silos between business areas is essential. “There is often an attitude that procurement is only there to buy, and finance exists simply to control spending costs,” says Mr Woode. “Conversations can be confrontational when it’s far better for departments to collaborate.”
In practice, proper interdepartmental engagement offers significant risk reduction. A food company that Efficio worked with showed how to do this well, bringing together multiple teams into the discussion. The result was that everyone started working with the same key performance indicators, substantially reducing risk and improving profitability.
Meanwhile, a UK manufacturer worked with Efficio to create a top-down view of KPIs, ordering by priority and recognising both challenges and new opportunities - targeting earnings growth through a reduction in supply cost and offering premium delivery services.
Confidence through information
As CFOs drive engagement on these topics, they must be sure to have an all-encompassing, holistic understanding of the risks and potential effects throughout their businesses. They also need to consider how to obtain the right detailed information from their company’s chief procurement officer (CPO) and other departments. The questions they ask will be essential to the quality of the answers they receive.
There are several steps they can take to do this well. In their discussions with CPOs, CFOs should ask for complete information on which products, suppliers and categories are critical to their business. Suppliers should be segmented to prioritise the highest-risk ones for a more thorough investigation. Looking at the most critical products and suppliers, CFOs must ask for a map of where commodities and goods are supplied from.
This map must be augmented with a clear risk profile for each critical product and supplier, detailing the core risks and the severity of each, bearing in mind the full geopolitical situation, including tariffs, foreign exchange, freedom of movement of people and goods, sanctions, general supply and market risks, and so on. This assessment should be multi-tier, not just level one in the supply chain, drilling down as far as possible. The expected impact should be detailed and could include cost increases or lack of goods and services.
It is also essential that the questions encourage collaboration rather than a feeling of criticism. “Asking procurement heads how they have identified costs and risks, just as with an external contractor, is vital. The questions should not be confrontational, but involving, and they should help the CPO to structure the answer,” explains Mr Black. “These questions cannot be answered by finance alone or by procurement or the supply chain alone. All parties need to communicate in detail.”
Using data to tackle risks
Armed with this information, CFOs and their colleagues can work together to model profitability and revenue impacts likely to result from specified changes, agreeing potential responses to mitigate the dangers. “Some of the questions they may wish to consider include whether they understand the trade-offs they face, such as whether currency devaluations will make it easier to export, but possibly raise the price of imported components,” says Mr Black.
Clear mitigation strategies for each risk could include the use of alternative or domestic suppliers, new trade routes and value engineering through modification of systems based on efficiency. In addition, it may be important to consider raising prices to offset higher costs or offshoring some production.
While such approaches are well within the typical expertise of procurement officers, pressure to drive cost out has, in the worst cases, encouraged excessively slimming down essential procurement personnel who actually boost efficiency. “Lack of time and resource is a real problem given the hundreds or thousands of suppliers companies may have and the current sea change of risks taking place. This work has to have the moral and financial support of the CFO, and be collaborative work, if businesses are to measure and mitigate the dangers,” adds Mr Black.
Efficio works with companies in all of these areas, offering the tools, resources and processes to analyse and deliver change in the supply chain. Its work with companies to identify and tackle risks is based on a three-strand approach. The first is to review the range of global scenarios that could affect a business. The next is to model the likely impact of each in detail. The final strand is to produce and help action a clear plan for procurement change.
CFOs are constantly presented with new risks to their supply chain. Given their position with a strong view of each business function, they must take the reins and make sure they have a full view of procurement risks, as well as a plan to tackle each danger. The only route to success is collaboration with every department. As a broker of procurement change, CFOs can be most effective in ensuring their supply future is secure and efficient, protecting long-term profitability.
This article originally appeared in the Raconteur, C-Suite Series “The Future CFO”